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Posted by: donmihaihai | March 30, 2008

Restructuring exercises.

China Energy Audit committee engaged PricewaterhouseCoopers(PwC) to conduct an independent review on China Energy for paying an additional RMB190 million to settle liabilities of Jiutai Guangzhou on top of the original RMB197.8million paid for the acquisition of shares in Jiutai Guangzhou. That was announced on 20 Mar 08. By the look of it, there don’t seem to be anything wrong and unless the RMB190 million liabilities were inflated and paid to related parties. But I really welcome this move by China Energy independent directors because this may open the door of questions(especially for independent directors and shareholders) for many “activities” which were done prior to listing of many China Companies which were included in the IPO prospectus under restructuring exercises(sometime company history). Due to lack of understanding from my part, for some companies, these “activities” look like a black box. Or it is really a black box?

For acquisition of share or certain unit of a company, I won’t be surprise that there are liabilities that come along with it. But if it is acquisition of assets, then there shouldn’t be any other working capital or liabilities. That is what I thought(am I wrong?) and China Energy belong to the 1st one. But it is the disclosures that are in question. China Energy can do more but they didn’t. In fact the whole thing is so beautiful done so minimum disclosure is required. China Energy should have met the entire minimum requirement for disclosure but it is the spirit not form that matter. In the IPO prospectus and announcement prior to the acquisition, despite this transaction was acquisition of shares, it was always being presented as if an acquisition that cost about RMB200 million even thought it did use net asset value and shares of Jiutai Guangzhou. The RMB200 million also come from the IPO proceeds and CIMB research report wrote that the management said the additional RMB190 million is from internal cashflow. So on the surface, the acquisition cost RMB197.8 million but in fact it cost double of that. And shareholders were told what is on the surface. It is only when one dig into the financial statements, some of the clues in the black box surface.

Is China Energy the only case? I doubt because recently I just came across another company, China XLX Fertiliser which look like doing the same thing. If there are nothing coming from independent directors, shareholders must make noise during AGM, not just to the executive directors but independent directors as well. China XLX Fertiliser was granted an option by XLX Chem(related company) to acquire the “acquisition asset” which were valued using net asset value(again, magic words) at RMB210 million. And the whole IPO prospectus with almost 300 pages there is only one line stated

“Acquisition of Old and New Plants(including additional land(1), assets and liabilities) (collectively known as the “Acquisition Assets”)”

Thank you, I missed that word “liabilities” even after reading through 3 to 4 times. Why was I searching for the word liabilities? Because this transaction looked like an acquisition of assets in the 1st place and I was shock later reading an announcement after IPO that “Acquisition Assets” come with many other things and Non Current Assets amounted to RMB726.2 million while Net Liabilities is RMB 516.2 million beside that China XLX Fertiliser repaid RMB235 million of liabilities in 4Q2007 for this acquisition. This is a hell lot of different compare to the amount RMB210 million and what were disclosed in the IPO prospectus. In fact beside that, I am still unable to determine what are in the “Acquisition Assets” and need FY2007 annual report to have a better understanding. That “Acquisition Assets” is a black box which I don’t understand.

While China Energy and China XLX Fertiliser are rather special cases and each China Company that listed in Singapore market is unique by itself. After reading through a number of these China companies prospectus I realised that the most important part of the prospectus is not the financial statement, use of IPO proceeds, competitive strength or expansion programs but Restructuring exercise, interest person transaction(IPT), conflict of interest transaction(CIT) and history of the company. Competitive strength is like writing story just like what I am doing here and expansion programs with use of IPO proceeds isn’t something special and can be change easily(just don’t understand why local journalists keep writing and pushing this as being transparent with companies doing it for the sake of doing it). The financial statements are not meaningful as well and I already known that I will be reading growing companies with high ROE, beautiful ratios before I go through it. And I won’t get much out of it unless read together with the restructuring exercises. In fact the restructuring exercise, IPT, CIT and history shown where and how is the company come from and how willing the owners in letting the company becoming a public listed company.

Taking China XLX Fertiliser as an example. China XLX Fertiliser was incorporated in Singapore in with a paid up capital of $100 and acquired XLX Fertiliser for total cash consideration of US$13.5 million. XLX Fertiliser obtained and approved which considered as a Wholly foreign owned enterprise which allows the tax benefits that we now being familise with. With a paid up capital of $100, China XLX Fertiliser granted “strategic Investors” convertible loan amount of US$7.12 which will give them an 11.28% ownership post IPO. In additional to that, China XLX Fertiliser procured a loan of US$8 million from ABN Amro Bank which is used to purchase XLX Fertiliser from XLX Chem except the “Acquisition Assets”.

What can we see from this transaction? With “zero” capital, the owner of XLX Chem is able to list most of their operations thru China XLX Fertiliser by selling 11.28% of the company at a very cheap price to strategic investors. Despite China XLX Fertiliser size, this should be considered as a high risk transaction because ABN Amro Bank charge Libor plus 7.5%(12.5%) for providing the short term loans which I consider as very high. While at the same time, a huge part of the assets were not being purchased by China XLX Fertiliser which can easily be explained in 2 ways. 1st, if all assets are being sold at that time, the owners need to give up at least another 15% of the ownership or so or borrow even higher amount with higher interest rates. 2nd, why sell their important assets at such a cheap price(almost free) to those investors? These two views can be used to see other China companies coming here to list as they usually will hold back their most valuable assets while at the same time not affect the operation. It is an understandable human nature.

Holding back valuable assets can be seemed by another China company, Ouhua as they hold back their most valuable assets port terminals. Saying that investors love assets light company with high ROE. Who helped them to come out with this explanation? Companies like Ouhua can never be asset light. (Side track. In the last few years, it seem that the trend for local market is asset light and companies selling their buildings and lease it back with Creative being the latest trend follower. While there is a huge amount of cash upfront but in the long run especially in land scare Singapore, if Creative intend to stay here for long, isn’t the best way is to own their property rather than lease it. Why the thinking change while looking at company compare to looking at our own situation? Any Singaporean will known the value of owning property in Singapore, especially owning freehold property.) For Ouhua, it is understandable, why sell their most valuable assets at a cheap price, as I look at it, if there is a sale, it must be at a huge premium, perhaps 3 to 4 X net assets.

Beside Ouhua, there are many other who hold back assets using one related but no ownership entity and lease them to the newly listed company. Those common assets are Land Rights, buildings, plants and machines. The most easily way to figure is looking at the ROE of a newly listed company. Those with super high ROE are the one that doesn’t come listing with everything. China Fertiliser ROE for 2006 was 194% and Synear ROE for 2005 was 131% are just two examples. The questions to ask are “how come ROE so high, even >100%?” “If so why listed because with this super high ROE, they don’t need to raise money anyway.”

Now here is the hardest part because it is about common sense, logical and knowing about businesses and transaction. Talking about China Energy future plan in the IPO prospectus which is acquisition of Phase 3 facilities in Shandong and shares in Jiutai Energy. These are huge plant & facilities so in the 1st place how do these come about? Who is building these and sell to China Energy without any premium? So what is the relationship? Common sense tells me that these cannot be from unfriendly entities so why separate them out?

While China Energy acquisitions look strange and illogical, Jiutian Chemical transaction look even worse, or just very stupid on the other party. At 24 Dec 2004, Auhua was paid US$5.6 million for its 93.52% of Anyyang Jiutian which was valued at US$6 million and is the whole operation of Jiutian Chemical. Jiutian Chemical was valued at SGD$66.68 million during IPO in May 2006. Using exchange rate of 1.5, Jiutian Chemical valued increased by about 7X in 1.5 yrs later!! Jiutian Chemical is currently valued at SGD$235 million at $0.17. In less than 4 years, the values of Jiutian Chemical increased by about 18X!! That is crazy. It is not about how well Jiutian has growth but how much money Auhua throw away. If there is someone who knows about the value of Jiutian Chemical, it should be Auhua. What more, after the sale of Anyyang Jiutian, Auhua still keep supplying Anyyang Jiutian raw material and become long term supplier. Well, I don’t find any common sense in this especially the management buyout ppls who are the one that get to see their share value increased 18X without putting in any money. Which mean they owned 39.16% of Jiutian Chemical without having to pay for it.

I bet I will going to see even more these kinds of restructuring exercises in the future.